We hope everyone had nice enjoyable holidays as we welcomed in a fresh new year!

The end of the year is often a time for reflections and resolutions so we made some time to reflect on the business landscape for money management. In an effort to get a fresh perspective on the industry we used the discipline of game theory to frame our study and to try to better-understand the interaction of various players.

For those not especially familiar with it, game theory can be described as the study of, “interactive, strategic decision making among rational individuals.” Game theory provides useful insights into some of the thorniest management problems by transcending academic disciplines as diverse as math, economics, politics, and psychology.

One of the very readable books on game theory is Co-opetition, by Adam Brandenburger and Barry Nalebuff. It dates back to 1996, but does a terrific job of applying game theory to real business situations and highlighting simple and useful principles.

Importantly, the very name of the book was coined to emphasize the balance of cooperation and competition in the business world. This open framework stands in stark contrast to the conventional model of pure competition and zero-sum games. In fact, the image of “cut-throat” competition comes to mind much more easily than any paradigm for business cooperation.

As our world has become ever-more complex, however, the mindset of pure competition has failed to capture many important relationships and opportunities that businesses encounter. An increasingly important player in such encounters is that of a complementor, which is essentially the opposite of a competitor. Brandenburger and Nalebuff explain, “A player is your complementor if customers value your product more when they have the other player’s product than when they have your product alone.” For example, hot dogs are more valuable to most people when mustard is available to garnish and complement the hot dog.

The notion of complementors may be more relevant to the investment industry than any other. The task of managing investments is so broad that many participants require more than one distinct service. For example, it is common that asset allocation/financial planning and fund management services have more value to an investor when paired than when used individually. As a result, the opportunity for collaboration derives naturally from both providers putting the client’s interest first.

One way to think of this is that, “Companies are complementors in making markets and competitors in dividing them up.” An important consequence, and one relevant for intra-industry relationships, is that the potential for growing the market by advancing complementary relationships may quite possibly be greater than that for competing for a bigger slice of the same pie.

As always, we appreciate your comments and suggestions regarding any aspect of the business which might make our services more useful to you. We hope you find our proposition compelling and always look forward to talking with you.

Business Update

Since I founded Arete nearly two years ago now, I have made a concerted effort to keep all aspects of the business current. I regularly review the business plan, the ADV, the website, and other materials to make sure you see and hear my current thinking. As part of this process, I have most recently reviewed and refreshed Arete’s mission statement.

First and foremost, the primary thrust of Arete’s mission statement has not changed and is not likely to change. I always want this organization to be about striving for “functional excellence in money management.” This statement also serves as my personal commitment to all of Arete’s investors.

When I first conceived the mission statement, I wanted it to be extremely clear that the company was created to deliver high quality money management. My feeling was—and is—that far too many organizations in the industry do not offer a compelling value for their investors. I wanted to clearly differentiate Arete in this respect.

In doing so, however, I failed to appropriately acknowledge all of the smart, hard-working, well-intentioned, and value-creating people and institutions in the industry. Indeed the population of all parts of the industry by high quality people has always been a big part of what makes the business so gratifying (and edifying) for me. The revised mission statement is a clearer and more robust expression of Arete’s objectives and its intended relationship with the investment community at large. Please feel free to check it out on our website at www.areteam.com.

When I think about business development, I always start at the same place—with the client. What do investors need? What are their biggest problems? Where does Arete’s mid cap product best fit into this landscape? How can we best work within the landscape of complementors, vendors, and clients to create the greatest value?

I believe there are some basic rules of engagement for this endeavor. One is that there needs to be a strong standard of fiduciary responsibility. Based on what I see and hear, investors want to be able to outsource more investing activities, but they don’t trust providers as much as they would like to. Many providers, especially the large financial conglomerates (but there were many), demonstrated clearly that systemic tendencies toward self-interest too often prevail over fiduciary duty. Can a community of unrelated providers do better? This is a major challenge. I do believe the industry can grow by better-serving investors. As a group, however, we must do a better job of earning and keeping trust.

Another important rule of engagement is transparency. I designed Arete with a high degree of transparency by disclosing the investment philosophy, mental models, market assumptions and other aspects of the business so investors can easily judge the merits of the offering. I have believed from the start that the better one understands what Arete does, the clearer its value proposition will be.

A couple of industry factors serve to dilute the value of transparency though. One factor is that the industry really has no uniform standards by which to judge products. A significant motivation of mine when I sat for the CFA was that I believed in the CFA Institute’s efforts to promote ethics and analytical rigor. Other organizations are also working hard to increase professionalism in the industry. Nonetheless, outside of a few notable successes such as the Global Investment Performance Standards (GIPS), there are very few evaluation standards to guide investors.

Another factor is that the proliferation of investment services, products, and providers has created a morass of messages and marketing for investors to wade through. The beneficiaries of such chaos are often weaker products—because it can be hard to differentiate them from better ones. There is an awful lot of noise to filter through.

Insofar as this is the case, I see at least a couple of opportunities to improve the investment environment. First, investment professionals need to keep working to provide a better set of “rules” by which to judge products and providers. Second, the best way to reduce noise in the market is for investors to vote with their feet. There are huge differences in quality among providers but unless investors make significant efforts to identify and reward quality, there is no economic incentive for things to improve. Ultimately, better rules and greater scrutiny of providers will reduce “noise” in the industry and promote a healthier ecosystem of investment services.

Throughout the upcoming year, as I continue to expand my sales and marketing efforts, I look forward to exploring ways to better-serve investors’ needs.

Thanks and take care!

David Robertson, CFACEO, Portfolio Manager

Market Overview

Market returns in the fourth quarter were very solid but did ease from the extremely strong showings of the second and third quarters. At the same time, the market’s “fear gauge,” the VIX indicator of market volatility, declined to levels not seen since late August 2008.

Overall, we saw the market shift gears from a massive rebound to a slower pace of gains. While the pace slowed, gains were driven by an increasing sense of normalcy as capital markets reopened and companies began raising debt and equity again.

Improvement in the equity markets was evidenced by a number of secondary offerings, by some acquisitions, and ultimately by the reopening of the IPO market. All of this progress, from a dead standstill in March, created a degree of momentum that kept pushing prices higher through the end of the year.

At this point, it does appear to us as if the market has gotten a little ahead of itself on valuation. That said, we still like the prospects for the stocks in our portfolio and continue to find interesting opportunities. Further, the Fed’s stance on keeping interest rates low for the foreseeable future is essentially a dare to not invest.

While this evidence presents a picture that is less than completely clear for the short-term, we don’t want investors to lose focus on what we view as attractive longer-term prospects for US stocks. One point we highlight is that we did avoid the cataclysm of a full melt-down of the credit markets and financial system. That threat has passed along with the market prices that reflected such a dire possibility. As I heard the other day, “The end of the world just doesn’t happen very often.”

In addition, we especially like the opportunity US stocks present. We are encouraged by many of the adjustments that individuals and companies have made and continue to see a strong foundation for future productivity growth. Also, valuations in a broad sense are reasonable, especially relative to some emerging markets which are being inflated by hot new money flows.